Fixing the Problems with Client Directed Voting

John Wilcox is Chairman of Sodali and an independent consultant on corporate governance to TIAA-CREF.

In their recent post on the Forum entitled Restoring Balance in Proxy Voting: The Case For “Client Directed Voting (available here), Frank Zarb Jr. and John Endean advocate Client Directed Voting (CDV), and describe how CDV might work. However, their model suffers from a significant problem. As envisioned by Mr. Zarb and Mr. Endean, CDV would offer beneficial owners only three choices: (1) to vote in proportion to other retail shareholders; (2) to vote as the board recommends; (3) to vote “contrary to the board’s recommendation.” This approach offers no improvement over the old discredited system of broker discretionary voting. In fact, proportional voting is a practice that violates the core governance principle of one-share-one-vote and increases the risk of manipulative practices. What is needed is an efficient model of CDV that is contextual and that can be customized to individual companies and their circumstances.

It is possible to conceive of a much more robust model for CDV in which retail investors would have access to a variety of meaningful choices for directed voting. CDV make sense if it could be structured to offer retail beneficial owners (RBOs) meaningful and customized voting choices, an audit trail, regular reporting and annual contract renewal.

To be meaningful, CDV should provide RBOs an array of voting analyses and choices from different types of institutional investors and other groups, including public pension funds, environmental and social investors, long term centrists such as TIAA-CREF, labor unions, advocacy investors, etc. It is interesting to speculate whether or how activist institutional investors, short-term investors or hedge funds might participate in a CDV system. It is also interesting to consider whether the voting recommendations of proxy advisory firms might appear on CDV platforms, with or without accompanying analyses.

Clearly the proponents of CDV would like to encourage standardized voting (e.g., “Vote my shares in the same way as TIAA-CREF unless I instruct otherwise.”). This might well be the choice of RBOs for annual meetings where companies are performing well, governance practices are sound, no contested resolutions are on the ballot and there are no other controversies or disputes. But even in these increasingly rare cases standardization makes sense only if real options are available and easily accessible to RBOs. Informed choice is important because the annual election of directors is no longer viewed as “routine” and shareholders increasingly want to scrutinize such factors as a company’s governance and annual compensation decisions as a measure of the independence and strategic competence of corporate boards before deciding how to vote.

Election contests are arguably the most important cases where RBOs are looking for objective voting guidance. It is unclear whether or not proponents think CDV mechanics and platforms would be applicable in proxy fights or how they might be adapted to the demands of multiple proxy mailings, revocations, etc.

CDV mechanics need to be carefully worked out:

As a first step, participating institutional investors would have to agree to make their voting decisions available in a central database sufficiently in advance of shareholder meetings to allow time for RBOs to review and decide how to vote — probably a week before the shareholder meeting. Given current practices and the pressures of the proxy season, timeliness could be a problem.

Broadridge or some other service provider would have to collect the voting decisions from participating institutions electronically, format the data to align with meeting agendas and proxy cards and make it accessible to RBO subscribers promptly.

The voting platform would presumably be administered by the same service provider that collects the data. It is possible, however, that proxy advisory firms and large record-keepers such as Computershare might develop their own proprietary platforms, thereby increasing competition and reducing costs.

RBOs would want end-to-end vote confirmation, enabling them to track their voting instructions into the final tabulation.

Companies would want an audit trail to ensure the accuracy of the voting results on contested matters, on shareholder resolutions or in case of a close outcome.

RBOs should have access to periodic summary reports of their voting decisions.

The CDV agreements between RBOs and their financial intermediaries should be renewed annually. This would be particularly important in cases where RBOs select a default voting process and later want to review other options. Also, as new institutional investors join the CDV system and make their voting decisions available, or where institutions change their investment orientation or voting policies, RBOs should be informed and offered an opportunity to reconsider their choices.

In the absence of voting options, customization, accountability mechanisms and other controls, CDV could be criticized as “dumbing-down” exercise or a thinly disguised alternative to broker discretionary voting, which is no longer permitted.

Early advocates of CDV proposed it as an antidote to quorum problems that they worried might result from the abolition of broker discretionary voting. As I have said in various comment letters, there are much easier and simpler ways to avoid quorum problems. In my view, the issue of quorum does not need to be considered in designing or evaluating CDV.

It is worth noting that although CDV has been discussed primarily in connection with voting by retail customers whose shares are held in broker name, it might prove useful to other types of investors as well. The ability to piggy-back on the voting instructions of well-regarded institutional investors could be attractive to other institutions, trust accounts, mutual funds and other entities whose shares are lodged in banks rather than brokers. A long-term design for CDV should bear this in mind and not consider solely the needs of individual investors in broker accounts.

This model requires the willingness of institutional investors and advocacy groups to make their voting decisions known in advance of shareholder meetings. In addition the technology must be developed to collect this information in a voting platform accessible to beneficial owners – all in the short time frame available during annual meeting season. Until we have such capabilities in place, it seems to me counterproductive to introduce a system of CDV that perpetuates old problems.

Fixing the Problems with Client Directed Voting 2010-03-05T09:12:19-05:00 2016-01-29T13:58:30-05:00Harvard Law School Forum on Corporate Governance and Financial Regulation

We are encouraged by the interest in this topic, elicited by our blog “Restoring Balance in Proxy Voting, including Mr. John Wilcox’s post above. The responses to our blog focused on the three choices we listed for “default” elections that shareholders could select, and suggested that the menu be broadened to include, for instance, the voting guidelines of institutional investors such as TIAA-CREF, or CalPERs.

It was not our intention to suggest that the menu of choices be limited only to the three listed. Indeed, the model for CDV outlined last year by the Society of Corporate Secretaries and Governance Professionals expressly contemplates that the platform could be expanded ultimately to include other choices, including voting that mirrors the voting patterns of institutional investors.

It is our view that CDV will become a tool to empower retail investors by providing them choices in addition to those they have today. In concept, the only limit on the potential menu of choices is the need to avoid overwhelming shareholders and thereby deterring their involvement.

That said, in first implementing CDV, we have to be realistic in our goals, and in formulating the first step. The cost and other developmental issues are not insignificant. Reform that strives for too much too soon is the unintended servant of the status quo. Microsoft started with DOS, not Windows 7.

Mr. Wilcox also suggests that the model be expanded so that it is available to some institutional investors, such as hedge funds. We would simply respond that our model was never intended to impose any limits on who could use the system.

Other features that Mr. Wilcox suggests, such as end-to-end audit trails, are available and could be implemented, subject to cost considerations. Will retail investors really demand this feature ? We don’t know. Will they think it is worth the cost? Again, we don’t know. One benefit of rolling CDV out one step at a time is that it will allow us to learn as we go.

We take issue with Mr. Wilcox’s characterization of CDV as “standardized voting.” It is important to keep in mind that we are not proposing to take away any choices that shareholders have today, only to add additional options. Shareholders would continue to receive their proxy materials, together with blank voter instruction forms, in the same manner and on the same time frame as they receive them today. Any “standing” instructions provided to brokers or bank custodians can be over-ridden before a vote is registered.

Institutional investors have used tools that Mr. Wilcox terms “standardized voting” for decades and continue to do so. They provide their proxy advisors “voting guidelines” and their ballots are voting accordingly absent further instruction from the investor. This permits institutions to focus their attention on the proposals and/or companies that merit further analysis. CDV would provide the same tool to retail investors. We do not believe that there is any policy basis for allowing institutional investors a free hand in using tools to make it easier to vote, , but depriving retail shareholders of the same tools. If we really care about the retail shareholder, we have to help them, too.

A policy that unrealistically assumes that retail investors are going to spend more time and effort than institutional investors on a given ballot is a policy that disenfranchises a significant portion of the shareholder community.

We also take issue with any approach that seeks to decide – on shareholders’ behalf – which voting choices are better than others, or which companies or ballots deserve more of their attention than others. If we want retail shareholders to participate actively and in greater numbers, we have to accord them the same respect that individual voters receive in presidential elections. We have to respect their vote even if we do not agree with the vote, or with the reasoning behind it. We believe that the retail vote is important precisely because it is a constituency that represents a different point of view and set of interests.

Along the same lines, it would be unthinkable to “edit” a ballot to remove choices that we did not agree with, or to discourage a voter from exercising his or her own judgment. An option that allows shareholders to vote by default consistently with the board’s recommendations makes sense because a shareholder who purchase a company’s shares may well do so because they believe that management is taking the company in the right direction. It would seem unfair, however to offer that option without offering also the opposite – to vote “no” by default. We personally would not choose as a default to vote against management in every case, but some shareholders (perhaps only a relative few) might wish to choose that approach. Remember that shareholders can always override their own standing instructions, and change “no” votes to “yes” on a case-by-case basis.

Again, we appreciate the comments relating to our original post and are pleased to see that a commenter as distinguished as Mr. Wilcox has joined in the important effort to increase retail shareholder voting. Some retail investors have stated that they do not vote because they feel that they “do not matter.” The only guiding principle for reform should be respect for the retail investor, and we should put reforms in place that values his or her input. If we do that, the investors will return to the polls.

We are encouraged by the interest in this topic, elicited by our blog “Restoring Balance in Proxy Voting, including Mr. John Wilcox’s post. The responses to our blog focused on the three choices we listed for “default” elections that shareholders could select, and suggested that the menu be broadened to include, for instance, the voting guidelines of institutional investors such as TIAA-CREF, or CalPERs.

It was not our intention to suggest that the menu of choices be limited only to the three listed. Indeed, the model for CDV outlined last year by the Society of Corporate Secretaries and Governance Professionals expressly contemplates that the platform could be expanded ultimately to include other choices, including voting that mirrors the voting patterns of institutional investors.

It is our view that CDV will become a tool to empower retail investors by providing them choices in addition to those they have today. In concept, the only limit on the potential menu of choices is the need to avoid overwhelming shareholders and thereby deterring their involvement.

That said, in first implementing CDV, we have to be realistic in our goals, and in formulating the first step. The cost and other developmental issues are not insignificant. Reform that strives for too much too soon is the unintended servant of the status quo. Microsoft started with DOS, not Windows 7.

Mr. Wilcox also suggests that the model be expanded so that it is available to some institutional investors, such as hedge funds. We would simply respond that our model was never intended to impose any limits on who could use the system.

Other features that Mr. Wilcox suggests, such as end-to-end audit trails, are available and could be implemented, subject to cost considerations. Will retail investors really demand this feature ? We don’t know. Will they think it is worth the cost? Again, we don’t know. One benefit of rolling CDV out one step at a time is that it will allow us to learn as we go.

We take issue with Mr. Wilcox’s characterization of CDV as “standardized voting.” It is important to keep in mind that we are not proposing to take away any choices that shareholders have today, only to add additional options. Shareholders would continue to receive their proxy materials, together with blank voter instruction forms, in the same manner and on the same time frame as they receive them today. Any “standing” instructions provided to brokers or bank custodians can be over-ridden before a vote is registered.

Institutional investors have used tools that Mr. Wilcox terms “standardized voting” for decades and continue to do so. They provide their proxy advisors “voting guidelines” and their ballots are voting accordingly absent further instruction from the investor. This permits institutions to focus their attention on the proposals and/or companies that merit further analysis. CDV would provide the same tool to retail investors. We do not believe that there is any policy basis for allowing institutional investors a free hand in using tools to make it easier to vote, , but depriving retail shareholders of the same tools. If we really care about the retail shareholder, we have to help them, too.

A policy that unrealistically assumes that retail investors are going to spend more time and effort than institutional investors on a given ballot is a policy that disenfranchises a significant portion of the shareholder community.

We also take issue with any approach that seeks to decide – on shareholders’ behalf – which voting choices are better than others, or which companies or ballots deserve more of their attention than others. If we want retail shareholders to participate actively and in greater numbers, we have to accord them the same respect that individual voters receive in presidential elections. We have to respect their vote even if we do not agree with the vote, or with the reasoning behind it. We believe that the retail vote is important precisely because it is a constituency that represents a different point of view and set of interests.

Along the same lines, it would be unthinkable to “edit” a ballot to remove choices that we did not agree with, or to discourage a voter from exercising his or her own judgment. An option that allows shareholders to vote by default consistently with the board’s recommendations makes sense because a shareholder who purchase a company’s shares may well do so because they believe that management is taking the company in the right direction. It would seem unfair, however to offer that option without offering also the opposite – to vote “no” by default. We personally would not choose as a default to vote against management in every case, but some shareholders (perhaps only a relative few) might wish to choose that default. Remember that shareholders can always override their own standing instructions, and change “no” votes to “yes” on a case-by-case basis.

Again, we appreciate the comments relating to our original post and are pleased to see that a commenter as distinguished as Mr. Wilcox has joined in the important effort to increase retail shareholder voting. Some retail investors have stated that they do not vote because they feel that they “do not matter.” The only guiding principle for reform should be respect for the retail investor, and we should put reforms in place that values his or her input. If we do that, the investors will return to the polls.

[…] also to help us retail investors vote our proxies. Now that a consensus is building in support of Client Directed Voting, a little funding could go a long way toward supporting proxy voting advice and systems for sharing […]